Why most traders keep dying a death with every trade they take
In case of traders, consistency of their methods will take care of profits from the trade.
One of the clichés of the market, particularly relating to trading, is to be mindful of risk. Everyone goes on and on about how we should risk only 1 or 2 per cent or some such small proportion of our capital in each trade. Everyone reads this and goes on to the next page without ever thinking about it!
I feel one of the main reasons for not applying this otherwise wise advice is that very few traders in the market really have an assigned ‘trading capital’! The typical trader just, well, trades, unmindful of the quantity he is supposed to do and unmindful of the amount of risk he is supposed to take. Moreover, there is a typical bunch of stocks on which a trader will have positions. This makes it a portfolio of stocks and, hence, the trader may also have to think in terms of portfolio risk and portfolio beta. But none of these are ever considered because the trades themselves are seen on an individual basis!
As Mark Douglas put it, this is the reason why traders keep dying a death with every trade of theirs. Eventually, the strain becomes too much, lack of success becomes demotivating and ‘relative’ success of others becomes a factor to abandon what one is doing.
I heard my old friend Raamdeo Agrawal say on TV the other day that in investing one mainly has to address the downside and leave the upside to fend for itself. He is a value investor and, therefore, believes if he has found the right stock, the upside will take care of itself.
It’s the stock market’s discovery process that then creates multiple levels of returns on your investment. But the process of addressing the downside prepares the mind to deal with non-performing investment. This is very similar to what we stated earlier, about risking only a certain amount of money in your trades.
In case of traders, consistency of their methods will take care of profits from the trade. He should, as Raamdeo says, allow the method to determine how much profit can accrue in a trade! What really happens is that people will find Raamdeo’s advice rather easy to handle when it comes to investment but will completely ignore it when it comes to trading!
That is silly, because trading and investing are essentially the same, with different time horizons for the life of a position! When it comes to trading, they are all over the place with non-performance over the next N minutes! They worry so much about the profits that they overlook the fact that risk should be a concern!
Ultimately, they end up with small profits on successful trades and large losses on unsuccessful ones. The chain is easy to break. The method is the door, and faith in the method is the key to that door.
The method itself will tell us about the risk involved. Look carefully at that and then allow the trade to run as per the dictates of the method. Value investing calls for remaining invested until price and value meet eventually. That may take months, sometimes years and sometime decades. It is a style that is not for everyone, as it needs a certain mindset. In quite the same manner, when one trades using a method it demands that you allow the possibilities of the method to come through. That may take hours or days or sometimes weeks. Once you adopt the mindset of accepting the downside risk and allowing the method to take care of the upside, you can get out of the persistent problems that most traders face.
A good example to use here would be Titan (or, for that matter, any trending stock).
In the chart, we find three timeframes – 30 min, daily and weekly and it is apparent that a good uptrend is essaying in all time frames. While intraday chart shows some ongoing pullbacks, the daily chart shows just one interruption in the trend – where the trendline was broken (marked X) and then trends resumed (marked with an arrow). In the weekly chart, we find that this break in trend was just a minor poke on the downside (see the small arrow) and the uptrend remained largely intact all through.
In this example you will find that dealing with the downside required very little effort on the daily and weekly charts but needed more attention on the intra-day chart. Therefore, it is easier to remain invested in Titan using just a trendline as a risk definer (that’s the simplest it can ever get!).
Trading requires you to be a lot more active and here comes the trouble. We can see in the 30-minute chart that the main trend remains upward, because the dips respect the trendline and every bottom is a higher one, as prices keep thrusting to new highs. So, we need to remain long in this name. But traders also have to deal with corrective phases because, they are a lot closer to the market action than investors.
Keeping it in line with Raamdeo’s advice of watching the downside, we can keep looking for two things – first a break of the support trendline and second, a change in the higher top-higher bottom pattern. Until this occurs, the stock is into an uptrend (which, anyway, is being signalled by the weekly and monthly charts) but neither has occurred so far. So, the longs are to be retained through the corrections.
You can also do something additional. Once the correction is complete and the trend resumes, you can get back in with additional positions. Small trendlines have been drawn in the intraday chart that signals resumption of the trend with the break of minor trendlines. (Of course, it is possible to do the same in the higher timeframe charts as well, but that would require more efforts. As a trader, you are prepared for additional engagement with the market. As an investor, most of us are not).
Watching the downside means you decide the risk. That’s all you control. The reward is decided by the market; you do not control that ever. But your method can help you track the market’s intent.
Leave it to the method to do that work. In the example cited, Titan seems interested in moving higher and giving us more profits. It is our job to take them. But the way we can do that is by being able to address the downside risk and allow the market to tell us when that is getting out of whack.
Here, we have used a simple trendline to define the ongoing trend. As long as it doesn’t break, we can breathe easy on our investment. If the bullish patterns are intact, we can re-enter when the trend resumes. It’s as simple as that. Just let the market do the talking.